Three Signs That NEVER Fail to Predict a Bear Market

It’s too early to know if this is just a head fake… or the start of a bear market.

Our old friend Mark Hulbert at the Hulbert Financial Digest thinks a bear market is developing. Citing the work of Hayes Martin of investment consulting firm Market Extremes, Hulbert says there are three indicators that never fail to predict a bear market:

In fact, no bear market has occurred without these three signs flashing at the same time. Once they do, the average length of time to the beginning of a decline is about one month, according to Martin.

The first two of these three market indicators – an overabundance of bulls and overvaluation of stocks – have been present for several months. Back in December, for example, the percentage of advisers who described themselves as bullish rose above 60%, a level Investors Intelligence, an investment service, considers “danger territory.” Its latest reading, as of Wednesday, was 56%.

Also beginning late last year, the price-earnings ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rose to its highest level since the benchmark was created in 1984 – higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

The third of Martin’s trio of bearish omens emerged just recently, which is why in late July he advised clients to sell stocks and hold cash. That’s when the fraction of stocks participating in the bull market, which already had been slipping, declined markedly.

One measure of this waning participation is the percentage of stocks trading above an average of their prices over the previous four weeks. Among stocks listed on the New York Stock Exchange, this proportion fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high.

It was one of “the sharpest breakdowns in market breadth that I’ve ever seen in so short a period of time,” Martin says.

Up? Down? We’re not sure… and not worried. Following the old dictum “buy low, sell high,” we sold out of the US stock market a (too) long time ago.

And following our new dictum – “forget the best, just sell the worst” – we are aiming to avoid some of the stock and bond markets’ worst days… which we believe lie ahead.

Why do we think so?

The answer is in our new book, Hormegeddon. Our friends have promoted it so vigorously we’re almost ashamed to mention it. But it explains a much overlooked phenomenon: An investor can survive a lot of failure, but too much success kills him every time.

Allan Sproul, the president of the Federal Reserve Bank of New York from 1941 to 1956, clarified the process in 1946 (thanks to Grant’s Interest Rate Observer for bringing this to our attention):

As gilt-edged securities, both public and private, rise in price under pressure of the abundant money supply, funds flow ever-increasingly into lower-grade securities, and into equities, and into commodity, real estate and other markets.

Journalist Henry Hazlitt elaborated:

Interest rates can only be held down to present levels by continually watering the supply of real capital through a continuous injection of new money and bank credit.

As ultra-low rates continue, milestones are hit. In 1946, the Union Pacific Railroad was able to borrow at 2.51% – a record low at the time. But it was a solid business. Today’s credit-financed lending bubble finds borrowers with neither tracks nor trains.

Rwanda recently borrowed $400 million – an amount equal to 5% of GDP –at less than 7% interest. Surely, that is a milestone too.

And so is the following, from our ace investigator, E.B. Tucker. (E.B. is working with me on a brand new project, which you can find out more about here.)

I spoke with someone today who got a loan from LendingClub.com last week. Have you heard of it? It’s a website where prospective borrowers post a listing detailing their background and capital needs. Then “investors” fund the loan and Lending Club takes an origination fee of about 3-5% for setting it up. That fee is deducted from the borrowers funds when money is transferred.

His rate was 17.5%, and truthfully I’m shocked he found someone to lend the money. He said he’s making $80k as a W2 salaried employee. He has a mortgage (relative lives in the home), he rents an apartment, he’s in a lease dispute over a previous apartment and he has plenty of monthly payments including a $500/mo car payment not including insurance. So he’s not that good of a credit risk. He said the loan was to consolidate credit-card debt, which he has over $35k of.

But someone privately funded the deal and gave him $35k! Lending Club took 3.7% as a fee, and he got the rest.

Great business model, no? You get money from people who are desperate for yield… you lend it to people who are desperate for cash… and you take your fees off the top. Then, if the loans go bad, it’s not your problem.

E.B. continues:

I asked him if he plans to pay the investor back.

“Maybe. If things go well, sure. But if I lose my job, which I might, I’m not paying this idiot back…”

Further Reading: Bill’s new book, Hormegeddon, explains the secret behind the way he does business, the way he has built his family, the way he manages his friendships and his affairs. And it explains this secret in the context of everything that is going on in America today… so you can see exactly how it applies to the world around you. To read a review of Bill’s book… and learn how to claim a hardcover copy before it’s available on Amazon.com, or anywhere else, read on here.

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